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Is the ISEQ relevant any more? Back  
Des Doran examines the use of the ISEQ and other indices as benchmarks in the context of European and global investment opportunities
The question of whether the ISEQ index is relevant to investors in the new millennium can be answered quite definitively as Yes… and No, with reservations! We need to be clear on what the purpose of an index is before we can assess the question properly. Indices are now a big business in their own right with the futures and options trading on them running into billions. Quite apart from their advertising value, the intellectual property rights to indices represent a major business.

However, for most people, an index serves one useful purpose - it allows them assess whether their choice of stock is better than the average - in other words it provides the benchmark. One criterion on whether an index is relevant is that the index must be a good performance replicator of a typical portfolio.

The best known index in the world is probably the Dow Jones - paradoxically it does not replicate a typical portfolio in any way. It is unweighted so that the change in a small stock has the same effect as an equivalent change in a major stock. In real life, an investor will hold far more of the major stock.

The ISEQ, unlike the Dow, is technically as good as any index can be. It completely represents the total Irish stock market and each constituent is weighted according to the market value of the company. As such it must be relevant. However, we have to decide whether anyone should invest and compare their performance on the basis of an individual and fairly small stock market. With the euro, one would expect most Irish investors to diversify their investments across many markets. From that viewpoint the ISEQ is less relevant.

Distorted weightings
Even if an investor is limiting themselves to Irish equities, the problem is that the ISEQ does not represent the normal distribution of holdings of Irish investors. The ISEQ index takes all the quoted equity of companies listed in Dublin and registered within the island of Ireland, excluding a few small exploration stocks.

The biggest stock is Elan, the pharmaceutical company. It now represents 20 per cent of the index. What this means is that if Elan ever goes up 10 per cent, the index will go up 2.0 per cent. In the six months to June, the ISEQ fell about 1 per cent. However, Elan rose over 70 per cent. Stripping out Elan, we would estimate that the rest of the Irish market fell about 10 per cent. It is estimated that Irish investors hold less than 10 per cent of Elan, the balance being held by overseas investors - predominantly Americans. For this reason alone, the ISEQ index is not representative of the average holdings of the average Irish investor.

There are further distortions, one example would be Eircom where, as we all know to our cost, 35 per cent is held by so-called long-term strategic investors, i.e. KPN and Telia, both of whom have become short-term investors as they have indicated their intention to sell their stakes at the earliest moment. But because 35 per cent of this stock is not in free circulation, the weighting of Eircom in the ISEQ which includes this, overstates the average holding of the average investor in the Irish stock market.

Does is all matter? Probably not must be the answer. The Irish stock market has, it has been argued, limited relevance to either Irish investors or, indeed, to the Irish economy.

The market capitalisation of the stock market, taken in aggregate, is ?45bn. This compares with gross national product of Ireland of approximately I?60bn. The ratio of the stock market to gross national product is therefore 75 per cent.

Large chunks of the economy are not represented in the stock exchange. Two big sectors, computers and pharmaceuticals, are dominated by overseas companies which are not represented on the Irish stock Exchange. Intel is one of the most important companies in Ireland, both in terms of size of its labour force, the quality of its labour force and the amount of money it generates within the economy yet it is not represented at all.

So, if the ISEQ index is not representative of the Irish economy nor is it representative of the average holding of Irish investors, can it be deemed to be relevant at all? Well, yes, as I said originally, in that it is a totally accurate representation of stocks listed in Dublin but that is probably as far as the relevance goes.

Global investing
The average Irish investor nowadays needs to be thinking globally and needs to find some measure of how well his overseas investment decisions are doing. It is logical for the Irish investor to look at the UK, mainland Europe and the US.

Looking at the US market is easy. The benchmark, the S&P 500, is transparent, clearly understood, very liquid, easy to replicate, even though it has 500 stocks, and very representative of the New York Stock Exchange. However, it does contain a lot of ‘old’ economy stocks. The new economy, including the technology, media and telecoms sectors, is better represented by the NASDAQ index. The differences between the two are large. An investor who chose some nice S&P stocks might have had a return of 25 per cent in dollar terms in the last two years. His neighbour, who chose NASDAQ stocks, might have had a return of 175 per cent!

So perhaps the same charge could be levelled against the NASDAQ 100 or the S&P 500 indices as is levelled against the Irish ISEQ index i.e. they are not relevant. However this would be unfair. They are all relevant bearing in mind what one is investing in. The important lesson to learn is that the choice of benchmark influences the return.

Back on this side of the Atlantic, the historical tendency of Irish investors to concentrate their investment in the UK market looks ever more irrational. What we need to be doing, going forward, is invest on a pan-European basis, including the UK.

If you then take an ideal representation of a pan-European stock market e.g. the MSCI Europe, including UK index, you get distortions. It is hard not to when you have companies such as Vodafone who are dominant in whatever index they happen to be. MSCI recently announced that they were going to alter the index to include only the ‘free float’ of shares. This will mean a big reduction in the weighting of such stocks as Deutsche Telekom and other privatised companies where the state still owns a large proportion of the shares. What it will achieve is to make the index a better representation of what investors actually can and do hold. The composition of most indices is often different from what people first think. The table shows the major broad categorisations at the end of June of two major indices excluding the ISEQ index. It can be seen that the broadly-based TMT sectors are significant in the markets but it is indeed questionable whether any of the markets represent the countries in which they are based.

Investing today means you are betting on the continuation of the telecoms revolution - now what did my Great Grandad say about railway shares over 100 years ago?

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